HealthEquity (NASDAQ: HQY), one of the nation's largest providers of health savings accounts (HSAs) and other benefits, has been disappointing Wall Street lately, cutting guidance and lagging the market. But a peek into the business reveals that despite its shares' poor performance, HealthEquity is taking market share with sticky and enduring products. . .
A challenging 2020
HealthEquity's stock really plunged in in March and April, dropping even deeper than the market average. Investors may have feared that high unemployment and a shrinking economy would wreck the company's earnings, which are indeed highly tied to employment. But those short-term fears look unlikely.
HealthEquity's most recent quarter ended in April 2020, a period with a solid sample size of insight during the worst of the COVID pandemic. . And in that potentially rough context, the company showed its ability to add customers even during a time when many employers are cutting back.
The overall HSA market is growing quickly as companies try to provide cheap health-care solutions. For most HSA providers, like health insurance companies or even banks, HSAs are an ancillary product. For example, there are now more than 850 credit unions offering HSAs. This shows both how fragmented the potential market is for HealthEquity, and how its competition is often focused on other things, like running a credit union.
A growing opportunity
You can see HealthEquity's dominance in HSAs in the numbers it posts. Those 850 credit unions manage less than $2 billion in HSA assets, HealthEquity tops the industry at $11.5 billion. HealthEquity has managed to take market share by being laser-focused on HSAs and customer service.
Nearly 60% of HealthEquity's revenue comes from recurring service fees for the administration of its HSAs. This is high-margin predictable revenue, and it drives the company's other sources of revenue. In the most recent quarter, this core part of the business grew 315%, bringing in $113 million.
Critics may point out that much of this growth comes from HealthEquity's August 2019 acquisition of WageWorks, but the company also managed to add more than 100,000 new HSA accounts organically. For context, in the same quarter of the previous year, HealthEquity added 89,000 HSAs. The company credits its culture of service, offering 24/7 live domestic customer service, as well as its unique ability to be a one-stop shop for healthcare, retirement, and benefits administration. .
Each new account provides HealthEquity with the ability to earn even more money from interest on those accounts, cross-selling other products like flexible spending accounts, or fees from when customers spend their HSAs, meaning modest account growth now can grow the bottom line for years to come.
Of little interest
HealthEquity's gets 25% of its revenue from "custodial" revenue -- essentially, interest coming from cash in the accounts it manages on behalf of its customers, like banks or insurance companies. Much of the guidance cut from earlier in 2020 came from the company lowering its expected custodial revenue as interest rates dropped.
In the most recent quarter, custodial revenue was $47 million, a 12% increase from the previous year despite lower interest rates than 2019. Custodial revenue is easy money, and will likely keep expanding if the company can steadily grow overall accounts and account balances. HealthEquity grows accounts through direct sales, but also by partnering with retirement plans and health plans. Consumers may find their next HealthEquity HSA through their employer, through their health care provider, or through their 401K custodian.
HealthEquity also wins when customers spend down their accounts, further diluting the importance of interest revenue. Its third source of revenue comes from what it calls "interchange" fees -- essentially, when customers use their HSA funds. Customers use HealthEquity's platform to directly pay their doctors or purchase qualified products. Almost like a payment processor, HealthEquity gets a fee, usually from the service provider, for facilitating these transactions.
In the most recent quarter, this revenue source jumped 74% to $32 million, as HealthEquity grew its average account size and negotiated a fatter slice of each transaction. Yet the company stressed that this segment was especially depressed, since many of its fee-generating services were held back as COVID-19 fears kept patients from seeking non-urgent medical procedures.
Ready to accelerate
Each aspect of HealthEquity's business -- account services, custodial, and interchange -- is challenged by the current high unemployment rate and struggling economy. The company still managed to post growth in each of its revenue streams, and it's are looking to speed up those gains.
CEO Jon Kessler is focused on fine-tuning the mechanics of the business, reducing costs, and transitioning its technology to more efficient platforms. In his words, HealthEquity is accelerating on multiple fronts.
HealthEquity looks like a recovery stock the market has missed. As employment accelerates, the stock may have a good chance of beating the market going forward.